Currency Trading Fuels Cryptocurrency GrowthARTICLE

By Mike Faden

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The number and market value of Bitcoin-like digital “cryptocurrencies” has exploded in recent years, with some experts attributing the growth at least as much to speculative currency trading as to their use in payment services.1,2

An analysis by researchers at the University of London and other institutions found that actively traded currencies numbered some 600 as of May 2017;3 new cryptocurrencies appear and disappear continuously, and about 1,500 cryptocurrencies have emerged since the introduction of Bitcoin in 2009.

The same analysis also highlighted an exponential increase in these currencies’ so-called “market capitalization” – calculated as the value of a currency unit multiplied by the number of units available. Though individual currencies remain highly volatile,4 the total market capitalization of all analyzed currencies reached a record $91 billion in May 2017, due largely to sharp rises in the value of Bitcoin and other actively traded digital currencies in the preceding months.

This article examines the cryptocurrency phenomenon and some of the factors contributing to its extraordinary growth.

Cryptocurrencies’ Promise for B2B Payments Services

Like Bitcoin, other cryptocurrencies being traded generally are based on distributed ledgers (blockchains) designed to enable fast, secure B2B payments and other transactions..5 The term cryptocurrency refers to the use of encryption techniques in the generation of the currency and the verification of payments. Bitcoin and many other cryptocurrencies also enable anonymous payments (because, like email, accounts cannot always be tracked back to a specific person) and use decentralized technology that isn’t controlled by financial institutions. The anonymity is one reason that some cryptocurrencies remain controversial, since Bitcoin and other cryptocurrencies have been used in some criminal activities.6

The extensive Global Cryptocurrency Benchmarking Study, produced by the University of Cambridge Center for Alternative Finance, says that most cryptocurrencies offer little to no innovation. “The majority of cryptocurrencies are largely clones of Bitcoin or other cryptocurrencies and simply feature different parameter values,” such as differences in the supply of currency and the way it is issued, according to the study.7

In contrast, the study says that other cryptocurrencies “provide novel and innovative features,” such as blockchains that use different methods for verifying transactions or support “smart” self-executing contracts that enable their use for a wide variety of applications. Notably, these cryptocurrencies are among those that are the fastest growing in value. Though Bitcoin still dominates, its share of total cryptocurrency market capitalization dropped from 86 percent in March 2015 to 72 percent in March 2017, according to the study.

By June, Bitcoin’s share had fallen even farther to less than 50 percent, as measured by CoinMarketCap.com.8 Several other currencies, meanwhile, had grown in market cap share, according to the University of Cambridge study: the second-largest after Bitcoin was Ethereum, a platform designed to support smart contracts (its currency is called Ether). The others included Ripple (XRP), which is being used by financial institutions to implement B2B payment services; DASH and Monero, which the study notes are privacy-focused currencies; and Litecoin.

Currency Trading and Speculation

Though there is growing acceptance of B2B payments and consumer payments in Bitcoin and a handful of other cryptocurrencies, some studies suggest that’s not the primary use of cryptocurrencies today. “Some evidence exists that as of today the main use case for cryptocurrencies is speculation,” the Cambridge study notes. “While a growing number of merchants worldwide are accepting cryptocurrency as a payment method, it appears that cryptocurrencies are not primarily being used as a medium of exchange for daily purchases. This is due to several factors, including price volatility and the lack of a ‘closed loop’ cryptocurrency economy, in which people or businesses would get paid in cryptocurrency and then use cryptocurrency as primary payment method for everyday expenses.” An analysis of users of one large cryptocurrency trading exchange and digital wallet provider found that in 2016, 54 percent used Bitcoin strictly as an investment, for example.9

Often the supply of a cryptocurrency is limited or even finite, which, if demand increases, tends to increase its value as a speculative investment.10 Growing acceptance of Bitcoin and blockchain technology in general may also tend to increase demand to trade other digital currencies.11

In a growing trend, cryptocurrencies are issued in a manner that’s analogous to an IPO; new companies and cryptocurrency projects issue an initial coin offering (ICO) that is used to fund development and reward early backers. The currencies may then be traded on cryptocurrency exchanges. For example, Ethereum raised the equivalent of about $18 million (in Bitcoin) through a 2014 Ether ICO.12 Notably, Ethereum describes Ether not as a general-purpose digital currency but rather as the “crypto-fuel” for the Ethereum platform; developers and smart contract users need it to pay for specific uses of the Ethereum platform, while users receive Ether for the “mining” process of completing and verifying blockchain transactions and for contributing to platform development.13,14

Further extending the analogy to company shares, cryptocurrencies may rise when there’s news of growing adoption of their underlying blockchain technologies. For example, analysts attributed a rise in the value of Ripple’s XRP cryptocurrency during May 2017 in part to banks’ plans to use Ripple’s technology for payment services.15 The price of Ether rose more than 20-fold during early 2017, fueled by industry backing for Ethereum technology.16

The Takeaway

There are hundreds of cryptocurrencies today, and their combined market capitalization grew to many billions of dollars in early 2017. Though a few cryptocurrencies are used to make consumer and B2B payments, experts say that speculative currency trading may be largely driving the growth in cryptocurrency value.

The Author

Mike Faden

Mike Faden has covered business and technology issues for more than 30 years as a writer, consultant and analyst for media brands, market-research firms, startups and established corporations. Mike also is a principal at Content Marketing Partners.

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